Which financial statement analysis tool compares the relative composition of accounts over time by expressing each item as a percentage of a base amount?

• A. Vertical analysis
• B. Horizontal analysis
• C. Ratio analysis
• D. Common-size analysis

Answer: (D)

Verified step by step guidance

1. Understand the concept of financial statement analysis tools: These tools help in evaluating and interpreting financial data to make informed decisions. Common tools include vertical analysis, horizontal analysis, ratio analysis, and common-size analysis.
2. Define common-size analysis: Common-size analysis is a method of expressing each item in a financial statement as a percentage of a base amount, such as total assets or total sales. This allows for easy comparison of the relative composition of accounts over time or between companies.
3. Differentiate common-size analysis from other tools: Vertical analysis focuses on analyzing financial statements by expressing each line item as a percentage of a total (e.g., total assets or total revenue). Horizontal analysis compares financial data across different periods to identify trends. Ratio analysis involves calculating financial ratios to assess performance and financial health.
4. Recognize the purpose of common-size analysis: It is particularly useful for comparing companies of different sizes or analyzing changes in the composition of accounts over time. By standardizing data as percentages, it eliminates the impact of size differences and highlights structural changes.
5. Apply common-size analysis: To perform common-size analysis, divide each line item in the financial statement by the base amount (e.g., total assets or total sales) and multiply by 100 to express it as a percentage. This provides a clear view of the relative importance of each account.